posted on 02 March 2016
by Ben Shepherd, Investing Daily
Stocks have been a roller coaster ride from hell so far this year; the graph of the S&P 500 looks like that rickety deathtrap that only the brave or the crazy would want to ride. The SPDR S&P 500 ETF (NYSE: SPY) is down 5.8% so far this year, and that's after a pretty good bounce in the past week. Dividends can make a world of difference though.
In 2015, when the general consensus was that the Fed was going to hike interest rates and might even be aggressive about it, dividend stocks struggled to gain ground. SPY ended the year up 1.25%, but SPDR S&P Dividend ETF (NYSE: SDY) gave up 0.7% as investors favored growth stocks in anticipation of higher rates. Thinking back just a year ago, some predicted an income stock apocalypse as investors ditched dividends in favor of bonds and growth stocks.
Tracking the S&P High Yield Dividend Aristocrats Index, an index comprised of S&P 1500 components that have boosted their dividends for at least 20 consecutive years, SDY holds some of the safest and most stable dividend payers available. Many of the ETF's 100 holdings will even be familiar to you if you follow the Income Portfolio in Personal Finance, with AT&T (NYSE: T), Realty Income (NYSE: O) and People's United Financial (NSDQ: PBCT) all in the top ten holdings.
While they throw off great income, they can get fairly volatile when the Fed is boosting interest rates fighting a phantom inflation. So SDY understandably wasn't at the top of many "Buy Now" lists, but now it looks like many might have passed up a bargain.
Now that the Fed is signaling that it will take a "more gradual approach" to future increases, the tables have decidedly turned. The CME's FedWatch, which uses 30-day Fed Fund futures prices to gauge the odds of a rate hike, currently puts just an 8% probability on a move during the Fed's March meeting. Looking further out, the odds of a hike don't break much higher than 25% until September, and even then the probability isn't much better than 1-in-3.
Between plunging oil prices, weak bank stocks, diving Treasury yields and slowing global growth, no one expects the Fed to make any sort of hasty move. And that means income investors can breathe a sigh of relief, at least for now.
Without rising Treasury yields encouraging investors to reallocate from relatively higher risk stocks into bonds, there isn't going to be an immediate rush for the income stock exit. There's already been a nearly 180 degree turn in sentiment when it comes to dividends stocks; while SPY is down better than 6% so far this year, SDY is currently sitting on a 0.6% gain. That's not too shabby in such a down year.
Add in a yield of just over 3% and you can be sitting on a decent gain come 2017. I think that's going to be true of high quality dividend payers generally, especially since fourth quarter earnings have shaped up pretty positively.
About half of the S&P 500 companies that have reported so far showed positive revenue growth in the fourth quarter, FactSet data shows that nearly 70% of them have beat earnings estimates. The biggest drags on overall performance have been the energy and materials sectors, which shouldn't come as any surprise, and earnings season would be even more positive if we could just back those out. Nearly three-quarters of energy companies have missed their estimates by a pretty wide margin, which is no surprise with oil hovering around $30.
Despite some obvious pockets of weakness in the global economy and sentiment at a point where investors are ready to punish any misstep, dividend stocks are still the way to go in 2016. The focus will have to remain on quality payers - steady to growing cash flows, relatively little debt and hopefully some value in terms of price - but they should show respectable gains in a roller coaster year.
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